A Member of Pat McKeough’s Inner Circle recently asked for his advice on a company that operates specialty retail stores selling cosmetics, fragrance, haircare and skincare products.
Pat likes the company’s strong brand, solid balance sheet, and online sales initiatives. However, he notes that the cosmetics industry is subject to unforeseeable shifts in demand and fashion trends.
Ulta Beauty, Inc. (Symbol ULTA on Nasdaq; www.ulta.com), operates specialty retail stores selling cosmetics, fragrance, haircare and skincare products. Altogether, the company provides consumers with a broad assortment of over 25,000 prestige and mass-market beauty products. Ulta’s shops also offer related beauty accessories and services.
The company has 1,264 stores in 50 U.S. states. Those locations are primarily high-end street-access stores with an average size of more than 10,000 square feet. Each location usually includes a 950-square-feet, full-service salon through which the company sells beauty services.
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Apart from its stores, Ulta Beauty also sells extensively through its website.
As of February 1, 2021, cosmetics sales accounted for 44% of total revenue. Skincare, bath, and fragrances accounted for 28%, while haircare products contributed 20%, services, 3%, and other, 5%.
Before COVID-19 disrupted business, Ulta Beauty was steadily increasing its market share and profits. The company had differentiated itself in a crowded marketplace with an assortment of brands across multiple categories and price points. Those labels include Clinique, Lancôme, MAC, and Estee Lauder, as well as brands sold only online such as Morphe, ColourPop, Kylie Cosmetics, and Juvia’s Place.
Though they only account for 3% of revenue, in-store services help create customer engagement and loyalty.
To create an innovative online presence, in November 2018, Ulta acquired augmented reality startup GlamST and artificial intelligence startup QM Scientific. Ulta Beauty’s GLAMlab tool now lets users try on makeup virtually before buying and QM Scientific increases user interactions.
The company’s investments in its online presence also include the personalized Ulta Beauty App, which makes it easy to shop online for in-store pick-up and to book a salon appointment.
From 2015 to 2019, Ulta Beauty’s revenue steadily increased 89.7%, from $3.9 billion in 2015 to $7.4 billion in 2019. Due to COVID-19, the company’s sales then fell by 16.8% in 2020 to $6.2 billion. Earnings per share soared 144.0%, from $4.98 in 2015 to $12.15 in 2019. However, they then fell to $4.66 in 2020 as revenue declined.
The COVID-19 pandemic forced the temporary closing of all of Ulta Beauty’s physical locations in March 2020. It introduced curbside pickup in May. By July 2020, however, all stores were reopened, except for salon and brow services. Those were fully resumed by January 30, 2021.
Inner Circle: A different growth strategy is planned in the face of challenges
In the quarter ended February 1, 2021, the company’s revenue fell 4.6%, to $2.2 billion from $2.3 billion a year earlier. Excluding one-time items, Ulta Beauty earned $193.4 million, or $3.41 a share, in the latest quarter. That was down 11.9% from $219.5 million, or $3.83.
In September 2020, Ulta Beauty announced that it would put its planned expansion into Canada on hold. It will instead improve its online sales platform. The company has spent between $55 million and $65 million to build out its Canadian infrastructure. It now plans to revisit international expansion once the pandemic has ended and retail sales are back to normal.
To ensure it had enough funds during the pandemic, the company borrowed $800 million from its credit facility last year. However, the company had repaid that money by the end of 2020. It finished the year without any debt and with $1.05 billion in cash.
Meanwhile, the company aims to use the retail economy’s weakness as an opportunity to renegotiate leases with landlords, including asking for store remodelling. It also plans to move operations to better locations.
Before the pandemic, Ulta planned to open as many as 80 stores in 2020. It ended up opening 30 new stores while closing 20, for net new store openings of 10.
The company has just launched a new growth initiative in conjunction with Target Corp. (symbol TGT on New York). The two retailers have signed a deal that will include a shop-in-shop concept to offer Ulta’s established and emerging prestige brands online and in select Target locations. The concept, called “Ulta Beauty at Target,” will launch at 100 stores starting sometime this year. The company plans to scale up to hundreds of these outlets over time.
The deal should let Ulta reach millions of new customers through Target’s wide network and help to greatly strengthen its brand awareness in the coming years.
Longer-term demographics remain strong for wellness products, including skin- and hair- care. Ulta Beauty continues to position itself to seize more of that business. For instance, in June 2020, it partnered with Credo Beauty to offer customers an exclusive beauty collection that divulges details about sourcing, fragrance, and ingredients. This should appeal to Millennials and Gen-Z consumers who increasingly focus on ethical sourcing.
Besides its sound balance sheet and product mix, Ulta Beauty’s business strengths include its innovative online presence. That integrates well with its strong customer loyalty program.
Of course, the market in cosmetics and related materials is subject to unforeseeable shifts in demand and fashion trends. But all in all, the company’s outlook is positive.
Recommendation in Pat’s Inner Circle: Ulta Beauty Inc. is a hold.
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